An Actuarial Pricing Method for Air Quality Index Options

Zhuoxin Liu, Laijun Zhao, Chenchen Wang, Yong Yang, Jian Xue, Xin Bo, Deqiang Li and Dengguo Liu
Additional contact information
Zhuoxin Liu: School of Economics and Management, Shaanxi University of Science and Technology, Xi’an 710021, China
Laijun Zhao: China Institute for Urban Governance, Shanghai Jiao Tong University, Shanghai 200030, China
Chenchen Wang: School of Economics and Management, Shaanxi University of Science and Technology, Xi’an 710021, China
Yong Yang: School of Arts and Sciences, Shanxi University of Science & Technology, Xi’an 710021, China
Jian Xue: School of Economics and Management, Shaanxi University of Science and Technology, Xi’an 710021, China
Xin Bo: Appraisal Center for Environment and Engineering, Ministry of Environmental Protection, Beijing 100012, China
Deqiang Li: School of Economics and Management, Shaanxi University of Science and Technology, Xi’an 710021, China
Dengguo Liu: School of Automotive Studies, Tongji University, Shanghai 201804, China

IJERPH, 2019, vol. 16, issue 24, 1-19

Abstract: Poor air quality has a negative impact on social life and economic production activities. Using financial derivatives to hedge risks is one of the important methods. Air quality index (AQI) options are designed to help enterprises cope with the operational risk caused by air pollution. First, the expanded Ornstein–Uhlenbeck model is established using an autoregressive-generalized autoregressive conditional heteroscedasticity (AR-GARCH) method to predict AQI for a city. Next, the average AQI is constructed to be as the underlying index for the AQI options. We then priced AQI options using an actuarial method with an Esscher transform. Meanwhile payoff functions for the options are established to let enterprises hedge against the operational risk caused by air pollution. Finally, we determined the price of AQI options using data from Xi’an, China, and the example of a tourism enterprise as a case study of how AQI options can be applied to hedge against operational risk for enterprises. With AQI options trading, enterprises can hedge against operational risks caused by air pollution. The applicability of AQI options is wide, it can also be applied in other cities or regions.

Keywords: air quality index; options; Ornstein–Uhlenbeck model; actuarial pricing; risk hedging (search for similar items in EconPapers)
JEL-codes: I I1 I3 Q Q5 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.mdpi.com/1660-4601/16/24/4882/pdf (application/pdf)
https://www.mdpi.com/1660-4601/16/24/4882/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jijerp:v:16:y:2019:i:24:p:4882-:d:293948

Access Statistics for this article

IJERPH is currently edited by Ms. Jenna Liu

More articles in IJERPH from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().